I confess: I experience a little Schadenfreude when I see a typo in The New York Times. That's because I write for a living, and I occasionally make mistakes myself -- so it's always nice to see others commit little blunders. It happened again recently. The publication was no Times and the error was no typo.
While flipping through Rhode Island Monthly, I spotted a little table titled "Hot Numbers." It listed Rhode Island's top stocks of 1994, along with their closing price on Dec. 31, 1994. It also asked, "What are they worth now?" and included their closing price as of April 1, 2008. Fair enough, right?
Well, I looked over the list, and found it a bit strange that among the three companies (out of seven) that hadn't merged or been acquired, one had risen modestly, while the others had fallen. Over more than a dozen years. And we're not talking about obscure little outfits here -- one was Textron (NYSE: TXT ) , and another was Hasbro (NYSE: HAS ) .
After a little research, I found that my suspicion was true: Whoever prepared this table didn't seem to know about split-adjusted stock prices. He or she may have just dug up a 1994 copy of a newspaper and grabbed prices from there, not taking into account the effect of ensuing stock splits. Hasbro, for example, split 3-for-2 twice during the period, so its stock didn't go from $28 in 1994 to $29 in 2008, but instead rose from about $11 to $29. Textron split 2-for-1 twice, meaning its shares didn't go from $47 to $57, but instead from about $8.50 to $57. A much better showing, no?
Be savvy about stock splits
We also have to be careful to understand historical prices when we look them up. Remember that split-adjusted prices are the ones that matter for our taxes, too. For example, my cost basis in the few remaining Time Warner (NYSE: TWX ) shares I own is roughly $1, even though their price was well into the double digits when I bought the shares.
Here's how the math works: Let's say you own 120 shares of Rent-to-Own Underwear (Ticker: EWWWW) and it splits 2-for-1. You now own two shares for each share you held before, giving you a total of 240 shares. This is why many naive investors get excited by the thought of splits. They think they're getting richer, or they at least like the idea of owning more and more shares over time.
But hold on. If those shares were trading at $40 each, pre-split (giving you a total value for your 120 shares of $4,800), they will be adjusted to compensate for the split. In this case, their value will be halved, to $20 each, giving you a total value for your 240 shares of ... $4,800. See? Not a huge difference.
Then there are reverse stock splits, usually executed when a company is struggling. My colleague Rick Munarriz recently discussed the concerns behind Bluefly's (Nasdaq: BFLY ) reverse split and touched on some past reverse-splitters, such as Sun Microsystems (Nasdaq: JAVA ) and Priceline.com (Nasdaq: PCLN ) .
If you're curious, you can keep up with upcoming splits at various online split calendars, such as this one from MSN Money. I see, for example, that Weatherford (NYSE: WFT ) has a 2-for-1 split coming up.
It's important to keep track of stock splits, so that you don't get unduly excited to see a stock's price suddenly quadruple (because of an ominous reverse split) or plunge (thanks to a regular split). If you see some fishy numbers, as I recently did, remember that they might be explained by stock splits.
The stock-split summary
One last useful thing to get out of this publication's error is a reminder that there are plenty of people out there who might seem savvy about stocks, but who aren't. But much of the time you really can't blame them. After all, few of us were taught anything about stocks in school.
So be pleased with what you do know, and strive to learn more. You can gain considerable insight into investing in our Motley Fool Inside Value newsletter, along with plenty of recommendations of promising stocks. I invite you to test-drive it for free and see for yourself.